Friday, 20 July 2018

With all eyes on Rome, remember Dublin and Athens and Tokyo and ...

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Anthony Peters, SwissInvest Strategist

So, this is yet another “crunch week” for the eurozone. To say that there have been more crunch weeks and decisive summits than I have had hot meals would, just for once, not be an exaggeration.

We might not be there yet but you must all agree that we have come a long way in the nearly two years since everything was being blamed on a bunch of naughty hedge funds who were frivolously shorting some of the European government bond markets in order to make a quick profit. As I say, we might not be there yet – and many still seem pretty convinced that we will not get there at all – but the efforts continue to square the circle.

Whatever is achieved this week will be on the back of a fierce austerity programme in Italy which Prime Monster Monti announced yesterday and which, like all austerity programmes, is based on spending cuts and tax rises. Announcing it is the easy bit; getting it through both houses of parliament will be a bit more difficult but, at the end of the day, it is in the implementation that the magic has to be sought – and that is a different matter altogether.

However, at this moment in time markets are not concerned with how Rome is going to capture fiscal revenues which have eluded it for so long and, as we know from the Greek experience, appeals to the better nature of tax payers for the salvation of the nation have a half life of next to zero. Cash will be moving from Italy to Geneva a darned site faster than those famous neutrinos were supposed to have been racing the other way.

Frivolity aside, the Monti government is trying to take the bulls by the horns in the same way as the Irish administration under Enda Kenny is doing. Next up in Dublin will be the announcement of €2.2bn of annual cuts and €1.6bn of tax increases. That is good as much as it is painful but the annual deficit will remain north of €10bn per annum even after these measures are introduced. Following the pattern of fiscal discipline which Dublin has set, the budget has to be squeezed even further and the process of spending cuts and tax increases is set to continue for several more years.

Heated exchanges

I struggle to see how a political shark pond like Italy is going get much beyond first base without some major parliamentary slanging matches and significant social unrest. There is no cheap and easy way out as Japan has shown us where QE has driven the debt/GDP ratio towards 200% and where the economy still stubbornly refuses to catch fire with any consistency. The 7%+ rally in European and US equity indices last week puts it up there as one of the best on record and there is considerable excitement into year-end. However, and for once forgetting the 39,000 points which the Nikkei clocked in January 1990, Japanese stocks have gone nowhere other than down for the past 20 years.

The US economy is of course looking a lot better as the Labor Report confirmed on Friday but austerity measures are still around the corner and what will happen when meaningful cuts in expenditure kick in is for anyone to guess. With a forecast budget deficit and funding requirement for 2012 of US$1.3tn anything can happen. Existing quantitative easing programmes are filling up and at some point the investment community will be called upon to step up to the plate. Whether a privately funded 10-year note is still worth the 2.06% at which it is currently trading is doubtful.

Pimco’s angle

Pimco’s CEO, Mohamed El Erian, certainly shows no signs of being impressed with the goings on in Washington and in a recent Hard Talk interview with the BBC made it clear that his remit is to protect the capital of and generate the best returns for his customers, not to support a government – any government – or an ideology. That’s how you get to the top of Pimco but that is not what the Treasury will want to be hearing.

Trip to Germany

Finally, I took a brief trip to Germany at the end of last week. After a few conversations – and trust me, this was not a statistically relevant sample – I got the distinct feeling that Hans Six-Pack reckons that the solution is to be found in the Deutsch Mark. When confronted with the issue of the risk of the Mark rising in value and the economy being hit hard, the general attitude appeared to be that that would be, all told, the lesser of two evils.

The appetite to pledge the future of the next generation and probably the one after that to funding the PIIGS (I saw a piece of politically correct research recently which hypocritically referred to them as the GIIPS) seems very limited. As I had already concluded before I went on the trip, it is not Germany which will be bailing out the eurozone but the 80m Germans; I do not think that they like that idea at all and Mutti Merkel knows it. She will be taking that knowledge into each and every summit meeting which she attends this week.

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